1. AGGREGATE EXPENDITURE AND EQUILIBRIUM OUTPUT
Chapter 20

2. AGGREGATE EXPENDITURE AND EQUILIBRIUM OUTPUT
The level of GDP, the overall price level, and the level of employment—three chief concerns of macroeconomists—are influenced by events in three broadly defined “markets”:
Goods-and-services markets
Financial (money) markets
Labor markets

3. AGGREGATE EXPENDITURE AND EQUILIBRIUM OUTPUT
The market for goods and services
Planned aggregate expenditure
Consumption (C)
Planned Investment (I)
Government (G)
Net exports (EX-IM)
Aggregate output (income) (Y)
The money market
The supply of money
The demand for money
Interest rate (r)

4. AGGREGATE EXPENDITURE AND EQUILIBRIUM OUTPUT
Connections between the goods market and money market (r ↔Y)
Aggregate demand curve (a function of P&Y, negatively sloped)
Aggregate supply curve (a function of P&Y, positively sloped)
Equilibrium interest rate
Equilibrium output (income)
Equilibrium price level
The labor market
The supply of labor
The demand for labor

5. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
aggregate output The total quantity of goods and services produced (or supplied) in an economy in a given period
aggregate income The total income received by all factors of production in a given period
aggregate output (income) (Y) A combined term used to remind you of the exact equality between aggregate output and aggregate income

7. INCOME, CONSUMPTION AND SAVING (Y, C AND S)
In a simple world with no government and a “closed” economy, that is no imports and exports
Households receiving aggregate amount of income can do two things with this income:
Buy goods and services → consumption
Saving

8. INCOME, CONSUMPTION AND SAVING (Y, C AND S)
saving (S) The part of its income that a household does not consume in a given period
Distinguished from savings, which is the current stock of accumulated saving
Saving ≡ income − consumption
S ≡ Y − C

9. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
Household Consumption and Saving
Some determinants of aggregate consumption include:
Household income
Household wealth
Interest rates
Households’expectations about the future
The higher your income is, the higher your consumption is likely to be
People with more income tend to consume more than people with less income
consumption function The relationship between consumption and income

11. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
The curve labeled as c(y) meaning that c as a function of y or consumption is a function of income
The curve has a positive slope
As income increases, so does consumption
The curve intersects the c-axis above zero
Even at an income of zero, consumption is positive (borrow or live off its savings)

13. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
Macroeconomics wants to know how aggregate consumption (the total consumption of all households) is likely to respond to changes in aggregate income
A positive relationship exists between aggregate consumption (C) and aggregate income (Y)

14. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
Because the aggregate consumption function is a straight line, we can write the following equation to describe it:
C = a + bY
Y → aggregate output (income)
C → aggregate consumption
a → a point at which the consumption function intersects the c-axis (constant)
b → the slope of the line, ∆C/∆Y (because consumption is measured on the vertical axis and income (Y) is measured on the horizontal axis)
Every time income increases by (∆Y), consumption increases by b times ∆Y
∆C= b x ∆Y and ∆C/∆Y=b

15. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
marginal propensity to consume (MPC) That fraction of a change in income that is consumed, or spent (or the fraction of a decrease in income that comes out of consumption)
marginal propensity to save (MPS) That fraction of a change in income that is saved (or the fraction of a decrease in income that comes out of saving)
MPC + MPS ≡ 1

18. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
To analyze the relationship between consumption and saving functions (Y=C+S), we will use device of the 45 degree line as a way of comparing C and Y
The 45 degree line shows all the points at which the value on the horizontal axis (Y) equals the value on the vertical axis (C)
Where the consumption function is above the 45° line, consumption exceeds income, and saving is negative
Where the consumption function crosses the 45° line, consumption is equal to income, and saving is zero
Where the consumption function is below the 45° line, consumption is less than income, and saving is positive
Note that the slope of the saving function is ΔS/ΔY, which is equal to the marginal propensity to save (MPS)

19. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
PLANNED INVESTMENT (I)
investment Purchases by firms of new buildings and equipment and additions to inventories, all of which add to firms’ capital stock

20. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
Actual versus Planned Investment
change in inventory Production minus sales
desired, or planned, investment Those additions to capital stock and inventory that are planned by firms
actual investment The actual amount of investment that takes place; it includes items such as unplanned changes in inventories

22. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
We will take the amount of investment that firms together plan to make each period (I) as fixed at some given level
We assume that this level does not vary with income
Planned investment is a horizontal line

23. AGGREGATE OUTPUT AND AGGREGATE INCOME (Y)
PLANNED AGGREGATE EXPENDITURE (AE) planned aggregate expenditure (AE) The total amount the economy plans to spend in a given period

24. EQUILIBRIUM AGGREGATE OUTPUT (INCOME)
equilibrium Occurs when there is no tendency for change
In the macroeconomic goods market, equilibrium occurs when planned aggregate expenditure is equal to aggregate output
aggregate output ≡ Y
planned aggregate expenditure ≡ AE ≡ C + I
equilibrium: Y = AE or Y = C + I

25. EQUILIBRIUM AGGREGATE OUTPUT (INCOME)
Y > C + I aggregate output > planned aggregate expenditure inventory investment is greater than planned actual investment is greater than planned investment C + I > Y planned aggregate expenditure > aggregate output inventory investment is smaller than planned actual investment is less than planned investment

28. EQUILIBRIUM AGGREGATE OUTPUT (INCOME)
THE SAVING/INVESTMENT APPROACH TO EQUILIBRIUM
Because aggregate income must either be saved or spent, by definition, Y ≡ C + S
The equilibrium condition is Y = C + I, but this is not an identity because it does not hold when we are out of equilibrium
By substituting C + S for Y in the equilibrium condition, we can write:
C + S = C + I
Because we can subtract C from both sides of this equation, we are left with:
S = I
Thus, only when planned investment equals saving will there be equilibrium

30. EQUILIBRIUM AGGREGATE OUTPUT (INCOME)
ADJUSTMENT TO EQUILIBRIUM
The adjustment process will continue as long as output (income) is below planned aggregate expenditure (Y<AE)
If AE>Y, reduction in unplanned inventory
Firms will respond to unplanned inventory reductions by increasing output
If firms increase output, income must also increase, consumption increases and so forth, until equilibrium is restored, with higher Y than before

31. EQUILIBRIUM AGGREGATE OUTPUT (INCOME)
ADJUSTMENT TO EQUILIBRIUM
If AE<Y, increase in unplanned inventories
Firms will respond to unplanned inventory increases by decreasing output
As output falls, income falls, consumption falls and so forth, until equilibrium is restored, with Y lower than before

32. THE MULTIPLIER
multiplier The ratio of the change in the equilibrium level of output to a change in some autonomous variable
autonomous variable A variable that is assumed not to depend on the state of the economy—that is, it does not change when the economy changes

34. THE MULTIPLIER EQUATION
Equilibrium will be restored only when saving has increased by exactly the amount of the initial increase in I
The marginal propensity to save may be expressed as:
Because ∆S must be equal to ∆I for equilibrium to be restored, we can substitute ∆I for ∆S and solve:
therefore or

35. DERIVING THE MULTIPLIER ALGEBRAICALLY
Recall that our consumption function is:
C = a + bY
where b is the marginal propensity to consume.
In equilibrium:
Y = C + I
Now we solve these two equations for Y in terms of I. By substituting the first equation into the second, we get:

36. DERIVING THE MULTIPLIER ALGEBRAICALLY
This equation can be rearranged to yield:
Y − bY = a + I
Y(1 − b) = a + I
We can then solve for Y in terms of I by dividing through by (1 − b):

37. DERIVING THE MULTIPLIER ALGEBRAICALLY
Now look carefully at this expression and think about increasing I by some amount, ΔI, with a held constant
If I increases by ΔI, income will increase by
Because b ≡ MPC, the expression becomes

38. DERIVING THE MULTIPLIER ALGEBRAICALLY
The multiplier is
Finally, because MPS + MPC ≡ 1, MPS is equal to 1 − MPC, making the alternative expression for the multiplier 1/MPS